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Private equity fund

Private equity going public? I haven't heard a valid reason why a private equity firm would need to IPO but will advise clients to short sell any that do. If a firm wants to keep and lure talent, it is optimal for them and LPs to stay private. Carried interest is the motivator. Apart from undermining private equity's core philosophy and marketing pitch of the advantages of being private, it's a sign the prospects are dire for big private equity LBOs.

Stock markets may change but investor behavior remains reliably consistent. Sad also to see some formerly good firms creating INEVITABLE conflicts between limited partner and shareholder interests. An IPO is a signal to LPs to get out of future capital commitments on the private equity secondary market.

Skill is rare. Often LPs would have done better simply leveraging a large cap value public equity fund. Adjusting for risk and comparing that long only return to the best hedge funds, performance was poor - in fact negative alpha. The FUTURE outlook for big private equity is worse. Large LBOs are dependent on cooperatively cheap credit which I suspect will dry up.

Efficient markets? Analysts at the banks that mispriced the offering will soon be writing euphoric reports saying the stock is "cheap" and has terrific long term growth prospects! Such hype and hysteria is great news for those able to exploit such pricing anomalies. Market inefficiencies and misvaluations still seem to be available to those with the skills to identify them.

It is comforting to see plenty of irrationality and out of ego there is always opportunity to make money. What did Goldman Sachs say to be left out of the underwriting? Did they dare to use the GS stock p/e and EBITDA in the comparables valuation or did someone on the pitch team point out their own IPO in 1999 did nothing to retain or attract talented employees? JP Morgan was also omitted so was it that Marcus Goldman and John Pierpont Morgan ALREADY have 100 year legacies?

Many hedge funds shut down last year. This is portrayed as a "negative" for the industry but it is healthy and Darwinian. "Shut down" rarely means "lost all the money". Beta dependence still bails out many weaker funds. We ought to lose at least the bottom decile ie get 1,000 shut downs each year so it is remarkable how few hedge funds have disappeared, so far. Hopefully the coming bear market, credit collapse and economic recession will reveal who has been swimming naked in the outgoing tide. Private equity WILL also be a prominent disaster as will any banks that don't manage credit risks and derivatives properly. Banks, insurance companies and private equity firms all use MORE leverage than hedge funds.

Alpha can ONLY be generated when many others will be wrong. There needs to be as much greed, fear, stupidity and emotion as possible in the markets. It would be worrying if no-one bought the Blackstone IPO, no-one put money in Brian Hunter's Solengo Capital, everyone loved hedge funds and always blamed themselves for losing money. If everyone became rational the markets might indeed become random and correctly priced. Clearly this is not remotely the case. The growth of the hedge fund industry has not reduced the vast INEFFICIENCIES in the financial markets. In fact there are more than ever before and that is good news for those with skill.

Hedge funds are now being blamed by some for the recent market volatility. Since "hedge funds" comprise a wide range of strategies, doing different things in different time frames, short and long, it is difficult to see how "hedge funds" can have much to do with it. If anything the recent global mini-correction could have become a major "correction" were it not for hedge funds covering shorts. We have also seen weaker hedge fund managers blaming everyone but themselves for performing poorly. If a trader loses money, it is the trader's fault. No-one else's. Events happen and risks are always present; if you are competent, you prepare and hedge for ANYTHING.

Brian Hunter of Amaranth fame is apparently getting going with a new fund. This is excellent news for skilled energy traders. Let's hope he raises billions. The more silly money out there the more opportunity for smart money to exploit it. I haven't seen the presentation materials yet but no doubt there are plenty of "one off event, thousand year storm, just bad luck, never happen again, strict risk control" powerpoint slides. Real traders do not lose $6 billion, EVER. But it is reassuring that there could be money out there prepared to invest in Solengo even when there are thousands of superior hedge funds. I asked a good commodities hedge fund manager about Brian Hunter; to quote "I made money out of him at Deutsche, more when he was at Amaranth and now it looks like I get the chance to make some more out of Solengo".

The best investments are often those that "experts" consider crazy at the time. The most correct opinions are usually the ones most vehemently opposed. Investors also have to be careful not to confuse intelligence with rationality. Some of the cleverest people around are very irrational. As John Maynard Keynes alluded to with beauty contests, don't buy the things you personally think are good, buy what others think are good. As Long-Term Capital and Amaranth and their unfortunate clients found out to their cost, being intelligent and rational does not help much if the market is not. The market ALWAYS wins those battles.

Some say greed and fear dominate the markets, but it is actually fear and fear. Fear of missing the boat OR fear of being on the boat. When the recession iceberg looms it will not make much difference which cabin you are in unless you have some true hedge fund lifeboats.

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